The fate of our investments and unemployed people (and politicians) depends heavily on the prosperity of our economy's public and private employers and their employees. For the last four years our economy and markets have been stuck in a "Great Recession." Now, once again, there are politicians and writers claiming we are starting to recover.
There are also claims in the other direction, that the U.S. must choose between bankruptcy and inflation. (e.g. the Avi Gilburt March 5 article "The United States has two choices: depression or bankruptcy").
They're both totally wrong. Readers should not be taken in by such fear mongering or unwarranted optimism.
Today the United States' economy remains stuck deeper than ever in an economic malaise - with absolutely nothing on the horizon to provide light at the end of the tunnel. But bankruptcy and inflation certainly do not threaten.
Major fiscal policy changes aren't in the offing (and wouldn't work if they were.)
Federal spending increases and/or tax reductions sufficient to get the economy back to full employment appear to be a non-starter due to Congress's unwarranted belief that federal debt is the same as state and local, business, and private debt - payable via taxes now or taxes later.
But it really doesn't matter because most fiscal policy alternatives open to the United States would be ineffective even if there were no debt fears (sorry Keynesians - Keynes wrote about the UK fiscal system where fiscal policy can be effective).
Even so, Congressmen cannot resist the urge to be seen as "doing something" so we have had various and sundry relatively piddly "jobs bills" and tax changes. The main effect of these has been to provide journalists and politicians something to talk about - but those that have passed have done little to fix our badly damaged economy and markets.
Relying on fiscal policies that have no chance of working in a timely manner is one of the major reasons we have had four years of unemployment, low profits and share prices, foreclosures and bankruptcies, and deficits at every level of government since unemployed people and failed banks and businesses don't pay taxes.
Why Fiscal Policies are not the answer
Unlike fiscal policy in the UK it typically takes months and often years to get a spending bill through Congress and signed by the White House and then months and years to implement it. Then nothing happens if it is a spending bill - for if there is one thing everyone knows it is that in the real world there are no such things as "shovel ready" projects that have already progressed through the regulatory process and delays.
Second, a great mass of business decision makers and investors are concerned by the national debt, probably because they do not understand how it comes into being, how it is maintained, and its significance or insignificance as the case may be. But their fears are real and may give them an adverse view of the future. So why ignore their fears - better to assuage them by having the Fed substantially pay it down. (Such an action would not result in more money in circulation.)
What I am saying here is that fiscal policy under our current structure is likely not to work or be possible. In any event, the responsibility to keep our economy prosperous without inflation (and without unemployment and its attendant low tax collections and profits) is the responsibility of our central bank, the Federal Reserve System and its seven governors appointed by the president.
Only the Fed has the tools necessary to get the economy going and it needs to get on with using them - whatever cocktail of them that will do the job. Our economy, markets, and devastated families have taken a heavy hit because it has not used them.
(Why fiscal policy and certain monetary policies do not work in the U.S. is explained in the January 1, Seeking Alpha article "Krugman, Keynes, and the Economy;" Why the national debt is not as big a problem as some make it out to be is explained in the December 29, article "The Economy And The Coming Collapse Of Bond Prices.")
The Federal Reserve is the only answer
Federal government spending increases and tax cuts, even if they were possible and of sufficient size, would take years to get through Congress and on to "shovel ready" projects - if they pass at all due to fears of the resulting deficits and increases in the national debt. And then, after all the naive political amendments to help cronies and supporters, their size might not be enough to restore prosperity in whatever economy exists at the time.
But why wait year for prosperity and the higher share values and tax collections prosperity would generate - the Federal Reserve already has more than enough powers and the ability to act quickly and to restore prosperity and its attendant jobs, tax collections, and profits, without inflation.
Unfortunately, the Fed has joined the Congress and White House in letting us down - because it is constrained by the inadequate educations, lack of real world banking and business experience outside of Wall Street, and the total lack of creativity and decisiveness of its bureaucrats and political appointees.
To paraphrase a late great senator - "the people and taxpayers of the United States are being crucified on a cross of Federal Reserve indecision and unworldliness."
The Fed could act. But has not.
Traditionally, the Fed responds to a recession by either or both of lowering the overnight rate of interest for banks or increasing the quantity of money in circulation. Its current efforts are focused on lowering the overnight rate and interest rates in general - in the naive belief of its governors that public and private employers and consumers respond to relatively minor interest rate changes - they don't. In their unworldliness the Fed's governors and others have confused the financial markets where financial instruments are traded with the activities of commercial banks and the labor and product markets of real economy where jobs and profits are created and taxes are paid
In any event lowering the overnight rate of interest doesn't do much because no commercial bank is going to loan out money that has to be immediately repaid the next day. But it is a signal that the Fed intends to provide more newly created money to the banks, which will then, when the economy is not stuck as it is today in a "great recession," tend to cause borrowing and spending to increase as it is loaned out.
And increasing the quantity of money so banks have more money to loan is the Fed's usual response when it is serious about increasing spending. In the past four years the Fed has twice (QE1 and QE2) engaged in such an activity - but both efforts failed because the banks were simultaneously required to hold the additional liquidity, on threat of closure, to the meet higher reserve requirements that were imposed at the same time.
A third attempt at quantitative easing is possible (actually it would be the first since the initial two were offset by the Fed's other policies). But now it probably won't work because the economy has been so deeply distressed for so long that there is less and less demand for loans by qualified borrowers. For example, most employers who have not yet closed have excess capacity and thus are not inclined to borrow to buy even more plant and equipment no matter how low the interest rate.
The Fed could turn things around
Flowing money to spenders indirectly via its traditional method of providing banks with loanable funds is not the Federal Reserve's only option. The Fed can also directly flow money to any potential spenders including the federal government or worthy people such as the retirees who built the economy the Fed, Congress, and the White House have been destroying despite their intentions to do otherwise.
And the Fed has been doing this. It has created new money and used it to directly fund a few recipients run by the cronies of its governors. Among those directly receiving funds from the Fed are Goldman Sachs (GS), Fannie May (FNMA.OB), AIG, and Deutsche Bank (DB) as well as to the IMF and ECB to help bail out the European banks that made bad loans to Greece.
But there are many things the Fed could do to directly flow money to ordinary Americans in addition to its favored few. It could:
- Create new money and channel it directly to potential spenders such as social security recipients (consumer spending would skyrocket);
- Strengthen banks' willingness to lend by significantly increasing their capital - offer (or require) to buy new non-voting shares in every commercial bank up to their current total of paid-in and retained profits;
- Stop paying interest on bank reserve deposits to encourage the banks to loan elsewhere.
- Reduce the national debt by making a one-time tax payment of $5trillion by tearing up much of both the debt it now holds and soon creates;
- Commit TFN to buying up to 50% of all new issues of private stocks and bonds so long as the other 50% was bought by arms-length 3rd parties;
- Require banks and the mortgage companies that they serve to give all mortgages an interest only option for next three years: etc.
There are many alternatives and all could be initiated in a matter of hours without Congress or the White House being involved.
Obviously I would prefer some of the options over others - but I prefer prosperity, major market advances, jobs, and budget surpluses so I could cheerfully accept and all.
Inflation will not result if there is more easing
And there is no need to fear that the Fed will create too much liquidity - if there is one thing the Fed decision makers understand, it is how to tighten up if total spending gets too large. So YES the Fed can create more money (QE3) and get it into circulation and NO that does not mean inflation from too much spending either now or in the future - for the Federal Reserve also has the power should we ever reach the state of having too much spending to instantly, within hours, withdraw any money from circulation that it deems excessive (sorry inflation alarmists - hours, not weeks or months, hours).
The current "Great Recession" will not be ended soon.
The Federal Reserve, Congress, and the White House do not appear to be in any way close to a solution to rescue the U.S. economy by getting enough purchasing power into the hands of consumers and businesses as the Chinese are doing. To the contrary, if the recent Federal Reserve governor appointees are any guide, the Fed will continue to have no macroeconomists with real world business or banking experience involved in its decisions. Thus it is likely to continue to concentrate its efforts on changing the virtually irrelevant levels of interest rates and helping the handful of too-big financial firms who got us into this mess in the first place.
In other words, investors need to be skeptical that the economy and the stocks associated with it will recover so long as the same old people at the Fed do the same old thing in the same old way over and over again.
So Today These Are The Best Investments
For investors the Fed's and White House's continuing insensitivity to the state of the businesses, commercial banks, and workers in our economy means the favored few will continue to prosper while the rest of the economy stagnates. Until the White House makes competent appointments and the Fed begins to carry out its statutory duty to maintain full employment, investors would be well-advised to stick with the White House and Fed's favored few: Goldman Sachs, Deutsche Bank, Bank of America (BAC), JPMorgan Chase (JPM), CitiBank (C), Credit Suisse , and Morgan Stanley (BJI).